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Iran has ambitious plans to rejoin the aviation community; being just another player is not the goal

Airline Leader

The longstanding economic sanctions are being removed, the market is open and deals are already being announced. The reopening of Iran presents a compelling proposition: a country of 80 million people, for decades excluded from the global market now not only inviting the West back in, but actively seeking engagement with it.

Summary
  • The reopening of Iran's aviation industry presents a significant growth opportunity, as the country seeks to modernize and develop its airlines and airports.
  • Iran's economy is projected to expand at a rate of 4%-7% in the coming years, providing a favorable environment for aviation growth.
  • Iran's domestic market has the potential to be the largest in the Middle East, with a youthful, educated, and tech-savvy population.
  • International airlines, particularly European carriers, have already started announcing their return to Iran, indicating

Iran's aviation industry, for years forced into survival and subsistence mode, is now one of the sectors that is being set up to lead the country's modernisation and development. Iran Airports Company CEO and chairman Rahmatollah Mahabadi, speaking at the CAPA Iran Summit in Jan-2016, noted that both the Iranian President Hassan Rouhani and the Roads and Transportation Minister Abbas Akhoundi have placed aviation as a priority area under the new national development plan.

Iran views investment in aviation not just as a way to improve its airlines and airports, but as an avenue for development of industry, technology and overall good governance and modernisation in the county.

From almost any angle, Iran represents a remarkable aviation growth prospect. Iran is the second largest economy of the Middle East and North Africa region - behind Saudi Arabia. However, the escalation of sanctions, as well as the decline in oil prices over the past 18 months, has caused the country's economy to contract sharply.

Iran's GDP in 2011, prior to the onset of the strongest sanctions, was USD528.4 billion. With access to global financial markets curtailed and oil exports throttled from 2.6 to 1.1-1.2 million barrels per day, Iran's economy - particularly the public sector where oil contributed 50% of income - suffered heavily. By 2014, Iranian GDP had shrunk by nearly a quarter to USD406 billion, according to World Bank estimates.

The International Monetary Fund projects that 2016 will see the end of the five year decline in the size of the Iranian economy. The expansion of oil production and exports, restored access to USD50-80 billion in previously frozen foreign assets and lower costs for trade and financial transactions will all help growth. Iran's economy is projected to expand at 4%-5.5% in 2016 and 6%-7% in 2017, well above the average for the MENA region.

Iran is moving quickly to re-establish its old oil markets, particularly in Europe. Plans are under way to add export production of 500,000 barrels per day through 1H2016, with French, Spanish and Greek firms already signing deals to take the majority of the increases. More production capacity, totalling another 500,000 barrels per day, will come online by the end of 2016, exporting into Europe and the developing economies of Asia Pacific, such as China, India, Indonesia and South Korea.

Sanctions not only had economic effects, but have left the country's travel and aviation sector depressed, underfunded and suffering from severe infrastructure deficits.

Iran has a competitive airline market with 16 local carriers operating a fleet of about 250 aircraft. It also has the second largest population in the Middle East. The Iranian market is youthful, educated and tech-savvy, all factors which would normally indicate a high propensity to travel.
However, Iran's airlines collectively handled less than 25 million passengers in 2014, across domestic and international routes. To put this into context, Turkish Airlines handled 54.8 million passengers with 260 aircraft in 2014. In the same year Lufthansa handled 77.5 million with 420 aircraft. Both Germany and Turkey have populations of similar size to Iran, although they possess significantly larger economies with more developed aviation and tourism sectors.

The Iranian domestic market has the potential to be the biggest in the Middle East. The country encompasses a huge land area, with widely spread population centres that are poorly served by underdeveloped road and rail networks. There is no high speed rail and while long distance road travel is common, thanks to the airline capacity shortage and government fuel subsidies, there are less than 1500km of major highways/expressways.

The international market also beckons, for Iran's local carriers and for international airlines as well.

Iran's national airlines' share of the local market has been steadily eroded over the past 15 years, thanks first to the expansion of Turkish Airlines and the Gulf trio of Emirates, Etihad Airways and Qatar Airways, and then due to the introduction of Middle Eastern and Turkish LCCs. Turkey and the UAE are Iran's two biggest destination markets, accounting for close to 60% of all seats.

Turkish Airlines CEO Dr Temel Kotil said at the CAPA Iran Aviation Summit that he expects demand for travel to Iran to double for his airline within two years. Turkish Airlines is already the largest foreign airline operating into Iran, with around a 12% share of international seats, just ahead of Emirates.

There is a wide range of potential travel categories that will spur growth in Iran. Iran has a diaspora of at least five million nationals who have left the country since the Islamic revolution. Major Iranian populations reside in most EU states, Russia, Central Asia, North America and even in Asia Pacific states such as Malaysia and Australia.

With Iran opening up to foreign investment - mostly from Europe and Asia, as certain US financial sanctions still remain in place - more and more business traffic will be attracted to Iran.

Iran also offers a nearly untapped international tourism market. The country has 19 UNESCO world heritage listed sites - matching the number in Brazil, Australia and Japan - and an array of natural, historical and cultural tourism attractions. However, it sees just four million international tourist arrivals p/a, a figure less than half that of regional peers such as Turkey or Egypt. There is a small but growing religious pilgrimage market, with significant holy Shia sites near Mashhad.

Iran hopes to increase tourism traffic to 20 million arrivals p/a by 2025, and has already adjusted visa regulations to be more tourism friendly. It is also seeking reciprocal visa waiver programmes with 28 countries to boost inbound tourism, However, 11 nations, including the US, the UK, Canada and France, remain excluded from the country's new visa on arrivals scheme.

Student markets are already a major travel segment. The Iranian Ministry of Education estimates that between 350,000 and 500,000 already study abroad and it has been actively encouraging students to seek high level graduate and post-graduate education internationally. In 2013, there were better than 60,000 Iranians studying in Malaysia, 11,000 in the UK and even 10,000 in the US.

International carriers, particularly European airlines, have already started to announce their return to Iran. Since mid-2015, when the nuclear deal was announced and a roll back in sanctions became an increasingly real prospect, a slew of new route launches have been announced.

British Airways, Air France, KLM, Air Astana, Lufthansa and Eurowings have all confirmed new Iranian routes. In addition, other carriers including Austrian Airlines, Alitalia, Ukraine International Airlines, Silk Air, China Southern Airlines and Turkish Airlines, have either announced capacity increases or that they are considering expanding their existing Iranian operations.

On the Iranian side, capacity expansion is not an easy option. Several airlines, including Mahan Air, Qeshm Air and Kish Air have revealed they plan sanctions, but in the short term they are hamstrung by a lack of aircraft. Many carriers have started talks with manufacturers and lessors for aircraft, but such deals take time to negotiate.

Iran's commercial aviation fleet is one of the oldest and most maintenance intensive aircraft fleets in the world. Nearly half are unable to fly, grounded due to safety, costs or a lack of spares and parts. The Iran Civil Aviation Organisation projects the country will need 80 to 90 new aircraft p/a over the next five years, and as many as 550 aircraft within a decade, at a value of more the USD20 billion.

Access to Western manufacturers will be a major boon for Iranian carriers. New or even mid-life second hand aircraft will bring with them improvements in efficiency, reliability, lower operating costs and offer better daily utilisation. According to Iran Aseman Airlines VP of executive affairs and fleet development Mohammad Gorji, around 60 aircraft could immediately be returned to service once manufacturers supply parts and maintenance checks are performed.

Iran issued future fleet requirements to major aircraft manufacturers in Oct-2015. Two major deals, one with Airbus and the other with ATR, have already been struck for national carrier Iran Air. The pace and size of the agreements were a most obvious sign of the priority Iran is assigning to a recovery of the aviation industry.

The agreement with Airbus covers 118 aircraft: 21 A320ceo and 24 A320neo narrowbodies; 27 A330ceo and 18 A330-900neo mid-sized widebodies; 16 A350-1000 high capacity widebodies and 12 A380s. The deal with ATR is for 20 72-600 turboprops.

The European manufacturers appear to have gained a first mover advantage, but deals with Boeing, as well as the smaller regional jet manufacturers are likely to come. Iran Air chairman & MD Farhad Parvaresh, speaking at the CAPA Iran Summit, announced that the carrier's 10 year plan includes the possibility of adding more 50-100 seat aircraft to its fleet to improve its domestic network with an "air taxi" type operation. Other Iranian carriers, including Meraj Air, Kish Air and Qeshm Air, have all announced they intend to acquire regional jets.

Shortly before the end of 2015, Iran's Civil Aviation Organisation acting director Mohammad Khodakarami announced that the country plans to split its aircraft orders evenly between the major manufacturers. US sanctions against Iran are notably more involved than the European sanctions and will take longer to unwind, meaning Boeing will need to be patient before any deal can be announced and finalised.

For Iran Air, these new fleet deals cover most of its requirements and are more than sufficient to re-establish the carrier as a major international network airline. At present, Iran Air has just 35 aircraft serving a network of 27 domestic destinations and 29 international. The composition and age of Iran Air's fleet mostly restricts it to sectors under eight hours.

The new aircraft orders also come with aggressive delivery timetables. The ATR turboprops will start delivery from Nov-2016 and will be completed by the end of 2018. Airbus deliveries are set for as early as 2016 to 2022, with the majority to be delivered by the end of 2020.

If these aggressive delivery schedules are kept, Iran Air will at least triple its current fleet size in the next five years. This sort of expansion would be a strain on any carrier of Iran Air's size and resource, and Iran Air is also advancing its fleet a generation or two in terms of technology, complicating matters even further. Iran Air employs around 7000 staff, roughly 200 workers per aircraft. With the tripling of its fleet by 2020-2022, it will need to expand its employment and its technical support infrastructure by broadly commensurate amounts.

In addition, a massive expansion of Iran Air's technical infrastructure will be needed to deal with new aircraft types and a growing fleet. Airbus has already announced it will provide assistance for airport and aircraft operations, training on the technical and academic levels, guidance in maintenance and repair operations, as well as industrial cooperation and wide harmonisation of Iran's air regulations.

Iran is clearly thinking big and long term for Iran Air. The country is favouring state owned corporations for its major deals, both within the aviation sector and outside it. This way, Iran retains a degree of control over the pace and direction that its modernisation takes.

While there is significant potential for growth, there are a number of key areas which represent potential brakes on aviation growth development.
Infrastructure is a key concern, particularly for airports, due to the cost and long development timeframes. Iran has nearly 70 airports, but chronic underinvestment during the sanctions period means that only around 50 of them are operational. Of those, most are small and short on capacity, equipment and passenger facilities.

Speaking at the CAPA Iran Summit, Iranian Minster of Roads & Urban Development Dr Abbas Akhoundi stated that only 10 of Iran's operational airports have sufficient infrastructure needed to meet the existing demand in the market.

Even major airports have had little spent on them. Tehran Mehrabad International Airport is the busiest in the country, handling better than 13 million passengers p/a, but has seen no major infrastructure upgrades in 40 years.

To overcome this sort of shortfall, the Iranian government has announced plans to invest at least USD8 billion to construct additional terminals at 27 airports. There are also plans to develop seven new international airports, each capable of handling long haul widebodies, around Ahvaz, Bushehr, Tehran, Qom and Araz over the next decade.

At least USD3 billion in investment opportunities are available for airport projects in 2016 alone. Iran estimates that airport infrastructure could require another USD10-15 billion in investment over the next few years.

The centrepiece of Iranian airport development is the upgrade of Tehran Imam Khomeni International Airport (IKIA). The airport predominantly handles international traffic, but is operating above its design capacity, with 6.5 million passengers in 2014. A new 'Salam' terminal with capacity for 5 million passengers is due to go into operation by the end of 2016, providing short term relief.

Iran wants to do more than just upgrade IKIA to keep pace with demand. A USD2.8 billion development contract has been already awarded to a consortium of Aeroports de Paris (AdP) and Bouygues Batiment.

The contract calls for development of sufficient capacity to handle 34 million passengers p/a by 2020. The long term master plan envisions expansion of capacity up to 90 million p/a by 2030, potentially making IKIA the fourth largest hub in the region, after the massive new airports in Dubai, Doha and Istanbul. Tehran possesses some connectively advantages compared to the Turkish and Gulf airports, but IKIA is also primarily limited to international traffic at present, necessitating very lengthy ground transfers to Tehran Mehrabad for domestic connections.

The objective is to turn IKIA into a major international hub and, eventually, an alternative to Istanbul and the Gulf hubs for East-West transit traffic. This is an ambitious goal and will require a concerted strategy among the various government authorities. Geography and timing are on Iran's side, but there are many "soft" issues to resolve, such as negotiating appropriate bilateral agreements and achieving a financial status that will support the underwriting of the extensive investment necessary for such an ambitious project.

For Iran's airlines, developing appropriate partnerships will also be an essential ingredient - at both operational and commercial levels.
Aside from surface capacity, there are also ATM issues to consider. Iran controls 1.6 million sqkm of airspace and the Tehran FIR has nine other FIRs abutting it, making it a key piece of the aviation network. Overflight traffic has increased from 550 flights per month to better than 1300 per month since mid-2014, mostly due to the necessity of avoiding restricted airspace in southeastern Europe, North Africa and other parts of the Middle East.

However, Iran has a long way to go to modernise its ATM system. Coordination and information sharing with neighbouring states is an issue and the country will not harmonise its ATM system with ICAO standards and practices until around 2019. Military-civil coordination also needs improvement, with 50% of airspace shut off to commercial traffic, thanks to more than 250 prohibited areas.

Iran has committed USD250 million to upgrade its ATM system, in partnership with Thales, but such modernisation is going to be progressive, rather than a single leap. The country is also opening more North-South and East-West air corridors to handle the increasing en-route traffic.
Manpower and training are another potential area of shortcomings. Iranian Minster of Roads & Urban Development Dr Abbas Akhoundi has stressed that aviation human resources development is a key priority. Iran's initial emphasis will be on increasing the number of professionals in the industry to meet the demands of expansion and modernisation, along with upgrading the level of competency in the existing workforce. Continuing training will also be needed to ensure the technical skill of the workforce is maintained and built upon.

To achieve this, Iran has extensive needs in the area of training capacity and in modernising its existing vocational and academic facilities to adapt to new requirements. The country is open to cooperation in human resources development, with Dr Akhoundi announcing that this could take the form of contract, JVs or partnerships or direct investment.

Regulatory adaptation is also needed to allow growth. Existing regulation and laws are sufficient to select and define the companies that will tender and invest in Iranian airports, but changes are needed to allow for public-private partnerships involving foreign entities and for example to allow Iranian airports to introduce charges such as development fees to fund construction.

According to Dr Bagherian, there are smaller regulatory changes needed to support such areas as allowing airports access to certain types of government funding or alternative international financing arrangements, before development projects can proceed.

Iran's existing legal and regulatory structures will require revision to bring them in line with international standards and practices. This is seen most keenly in the leasing and financing sector, which will be critical if Iranian carriers want to rapidly and cheaply acquire aircraft.

Dubai Aerospace Enterprise CEO Firoz Tarapore, speaking at the CAPA Summit, observed that lessors and aircraft owners ideally require the recognition of their ownership rights and recognition of aircraft registration outside Iran before they will be comfortable doing business. However, Iran is not yet a signatory to the Cape Town Convention, the treaty that protects the interests of lessors and aircraft owners.

Full implementation of the Convention would also bring peace of mind to lessors and aircraft financiers, as well as reducing funding costs for Iranian airlines. Iran's deputy Transport Minister Asghar Fakhrieh Kashan stated in Jan-2016 that discussions between the transport and finance ministries are under way on the subject, but signing up to a major international convention is an involved process that will take time to complete.

Continuing US financial sanctions are also an obstacle. Aircraft financing deals are mostly conducted in US dollars, but US Treasury sanctions remaining in place making it difficult to conduct large deals in the currency. US companies are also still mostly barred from deals with Iran.

None of these obstacles are insurmountable, but all will take time to resolve. Iran is surrounded by states that have managed rapidly and successfully to turn their national carriers and wider aviation industries into centrepieces of their development.

Iran has a bigger task ahead of it - its airlines and airports have to catch up with decades of modernisation in the rest of the world. But the country is clearly planning for the long term.

Iran's aviation potential is immense, and just one piece in a wider scheme of economic and commercial evolution. Removal of the initial round of sanctions provides the first step in that direction. There is plenty of work to do on the fundamentals, but a promising start is under way.